7 Surprising Hedge Fund Favorite Stocks

Includes: C, CIT, GOOG, LYB, S, SIRI, VRX
by: NakedValue

Here is a list of stocks that we were surprised to find among hedge fund favorites. While our reasons for surprise varied based on each stock, investors should take a closer look at the names on these list so they can decide for themselves whether or not they agree with the smart money investors.

Citigroup Inc (NYSE:C)
Notable Shareholders: Pershing Square, Paulson & Company, Soros Fund Management, Perry Corporation and Appaloosa Management

The financial crisis of 2008 is in the rear view mirror, and the broad market has roughly doubled since the March 2009 lows. However, the financial industry still seems to be caught in neutral. Bank bellwethers like Bank of America (NYSE:BAC) and JP Morgan (NYSE:JPM) still trade below book value, and it is not just a matter of valuations. Citigroup seems unable to find positives. The company recently completed a 10-1 reverse split to quickly shake the negative perceptions associated with a low priced stock. However, consistent with its recent fortunes, the stock price dropped following the reverse split, as some speculated that the stock split made it easier for short sellers to bet against the bank.

In what seems like a headline from the heart of the financial crisis, Fox Business is reporting that the Department of Justice will decide if Goldman Sach's CEO Lloyd Blankfein can remain at the firm. To be clear, we are not questioning the righteousness of the government's actions, but we are highlighting that financial firms are still under significant pressures that could affect their investment potential. It is because of this that we are surprised that Citigroup remains such a favorite among high profile hedge funds.

Of course, there are reasons to be bullish. Citigroup is among the cheapest banks in America. The company has a trailing P/E of 13.19, a forward P/E of 7.55 and a price/book of 0.69. The return on assets based on trailing data was 0.49%. This should improve going forward. Along with the company's international exposure and strong collection of financial businesses, the bank could reward investors once the industry enters the next phase of recovery.

Lyondellbasell Industries (NYSE:LYB)
Notable Shareholders: Greenlight Capital, Third Point LLC, Oaktree Capital

The Netherlands based company is a global provider of specialty chemicals and polymers. While the company jettisoned much of its debt during its restructuring and it sports strong global sales opportunities, the popularity of this stock could be surprising considering it is a cyclical name that is dependent on further economic strength-- a position that institutional investors are becoming increasingly cautious about.

The company started trading in the middle of 2010 with a stock price just north of $20, and traded as high as $45. With trailing P/E of 10.63, price/sales of 0.52 and price/book of 1.78, the company looks cheap when you consider that LYB had profit margins of 24.75% and return on assets of 25%.

Sirius XM Radio (NASDAQ:SIRI)
Notable Shareholders: SAC Capital Advisors, Renaissance Technologies, Liberty Media

The satellite radio company may have been on the brink of financial disaster just a few years ago. While the company has made a strong recovery with the help of funding from Liberty Media, SIRI's stock price is not cheap based on trailing statistics. For example, the company has a trailing P/E of 232.5, a forward P/E of 38.75 and a price/sales of 3.11 In 2010, revenues were $2.8 billion, a 14% increase from 2009.

Despite the rich valuations, we think there is more to the SIRI story. We previously listed SIRI among 5 Stocks That Could Double in Price because of the company's hidden pricing power. From 2008 to 2010, average revenues per user ("ARPU") increased from $10.56 to $11.73. This happened despite a court settlement related agreement not to increase subscription prices until the end of the year.

Notable Shareholders: Third Point LLC, Paulson & Co, Centerbridge Partners, Fairholme Capital

The New York based company provides commercial financing, leasing and other financial products to small and medium sized businesses. CIT's predecessor fell victim to the financial crisis, and after an accelerated bankruptcy, emerged in late 2009 around $30 per share. Led by John Thain, the company has stabilized its core businesses and operating costs.

In 2010, the company reported revenues of $6.36 billion. CIT trades at a trailing P/E of 19.01 and a forward P/E of around 28.7. It has a price/sales of 3.47, a price/book of 0.91 and return on assets of 0.82%.

To most investors, CIT's valuation ratios look bland. It's a classic low return company that's cheap on an asset basis but pricey on an income basis. But the trailing data doesn't tell the full story. CIT has abnormally high funding costs for a finance company but an attractive portfolio of loans and customer relationships. As such, the company's financials underestimate the business' full value to a large financial company with low funding costs.

Motorola Mobility (NYSE:MMI)
Notable Shareholders: Icahn Capital LP, Perry Corp

The company is the result of the spin-off from Motorola that created Motorola Solutions and Motorola Mobility. MMI was once the high growth subsidiary of the sleepy technology company, but once Motorola RAZR sales fell off, the mobile device subsidiary was unable to recreate its success and developed a reputation as an albatross on the company's financials.

On paper (and in practice) Motorola Mobility has a huge uphill battle ahead of it. While making a positively perceived decision to fully embrace the Google (NASDAQ:GOOG) Android operating system, the company still faces serious competition, as well as the disadvantage of lack entry. The company's highly anticipated Atrix and Xoom were generally acclaimed but underwhelming commercially.

With this in mind, why does the company have a high profile investor base? Part of the stock ownership is attributable to investors that piled into the stock before the spin-off, anticipating a strong sum of the parts story. But the continued interest is attributable to MMI's hidden value because the company is currently under represented in the smart phone industry. Not only do these phones enjoy secular growth trends, they also carry higher revenues per unit than feature phones. Once MMI fully enters the smart phone market, it should see an increase in revenues and margins.

In 2007, Motorola's mobile device unit had sales of $23.37 billion compared to the $11.05 billion in 2009. While this is a reminder of how far and fast MMI's business declined in recent years, it should also illustrate how quickly MMI's fortunes could change-- even with a moderately popular line of phones.

Sprint Nextel Corp (NYSE:S)
Notable Shareholders: Greenlight Capital, TPG-Axon Capital

Wireless companies struggled in recent years because of rabid competition and high capital investment requirements, but Sprint Nextel put itself on a different level of undesirability with its unfortunate acquisition of Nextel. Since then, the company has faced a steady stream of customer losses.

Why would this company be appealing to smart money hedge fund managers? The company's cheap price ensures minimal downside with lots of avenues for upside. From a macro stand point, the smart phone industry is growing fast enough that wireless companies could finally demand meaningful pricing power in the near future for wireless bandwidth. For Sprint, this could provide a strong tailwind to go along with potential earnings growth from cost optimization, so that margins are more in line with industry average.
The company's price/sales ratio was 0.53, compared to 0.98 for Verizon Communications (NYSE:VZ) and 1.48 for AT&T Inc (NYSE:T).

Valeant Pharmaceuticals (NYSE:VRX)
Notable Shareholders: Blue Ridge Capital, Ruane Cuniff & Goldfarb, Viking Global Investors, ValueAct Holdings, Seqouoia Fund

The pharmaceutical company is a surprisingly popular hedge fund holding because it is not cheap based on trailing fundamentals. The company has a price/sales of 9.67 and a price/book of 3.13. While some may think that the valuations are par for the course when it comes to this industry, among the company's shareholders are several respected value investing funds that would avoid such valuations.

Why is this stock so popular? Chairman and CEO Michael Pearson is a well respected manager with a strong history of success. Investors like the appeal of investing alongside Pearson as Valeant grows through acquisitions. Fresh off of a failed bid to acquire Cephalon Inc (NASDAQ:CEPH) at $73 per share in cash, VRX agreed to acquire AB Sanitas for EUR314 million in cash. Despite this, Valeant is expected to remain aggressive as it looks for acquisitions "of all sizes" . The company has the firepower to complete an acquisition bigger than that of Cephalon. As evidence of the market's support for its corporate strategy, after Valeant announced its offer to buy out Cephalon at a premium, both the target and the acquiring company's stock prices spiked.

Disclosure: I am long C and CIT shares. I may initiate a long position in S, SIRI, LYB over the next 72 hours.